“Did Pimco Opportunity Fund earn investors an average 2.5% return in each of the three years ended Jan. 31 — or did it lose nearly 2.7% a year? Was Brandywine Fund’s annualized return 6.5% for the five years ended in January, or just 2.8%?,” asks Theo Francis in today’s Wall Street Journal.

“It all depends on taxes.”

“At a time when showing a gain on a stock mutual fund has been depressingly difficult, taxes can turn a tidy profit into a puny one — or even a loss. Uncle Sam on average takes more than two percentage points each year from the returns of mutual funds held outside tax-deferred accounts, according to a study by KPMG LLP. But since fund returns are normally presented on a pretax basis and there are so many individual variables involved, it has always been tricky for investors to decide which funds offer the best results after taxes.”

” ‘Many mutual-fund investors have had the unfortunate experience of being surprised by large tax bills resulting from aggressive portfolio changes,’ says Arthur Levitt, who stepped down as chairman of the Securities and Exchange Commission in February 2001. After-tax performance ‘is a piece of disclosure has been missing for a long time,’ ” he says.

“The task just got a little easier, thanks to a SEC rule approved under Mr. Levitt’s watch last year and taking full effect this month. Funds now are required to calculate an after-tax return for each of their portfolios using a standard set of rules and to publish those results in fund prospectuses and in performance summaries used to market funds.”

“That is a big change from past practice when only some funds produced after-tax performance numbers, those that did used varying calculation methods and only rarely did the funds do much to publicize after-tax results unless it was to their benefit.”

“Small wonder, then, that few investors realize how important after-tax measures can be, says Mark Balasa, a financial adviser with Balasa Dinverno Foltz & Hoffman LLC, in Schaumburg, Ill. ‘They don’t even know to ask about it.’ “

“A major reason for confusion about after-tax calculations is that there actually are many possible answers — for the simple reason that investors pay taxes under many different tax rates. Investors also hold their funds for different lengths of time, which can affect whether gains are taxed at higher short- or lower long-term rates. And after-tax calculations also can be affected by numerous other variables, such as whether sales charges, or “loads,” are subtracted from results or ignored.”

“The SEC’s solution to all these possible variations? Do the calculations based on assumptions that won’t apply to everybody but at least provide some guidance on the tax impact of owning a particular fund.”

“As a result, the SEC requires funds to calculate after-tax returns using the highest individual tax bracket — currently 38.6% by statute. They must reduce returns for loads and show after-tax returns assuming they are sold at the end of one, five and 10 years and also assuming the fund shares are retained. In addition to prospectuses and fund profiles, the after-tax performance calculation must appear in advertising material that touts a fund’s tax efficiency.”